How DTC 2012 will change the way you save tax

How DTC 2012 will change the way you save tax

Direct Tax Code that is to come in effect from April 1, 2012 onwards will bring several changes to how you invest across various asset classes. So as an individual you need to rejig your investments a bit.

The original draft of DTC was much different from what you have in current form. Having said that you need to make you investments DTC-compliant.

Here's some more in depth analysis and the strategy you must follow once DTC 2012 kicks in:

How DTC 2012 will change the way you save tax

DTC will have significant impact on insurance. Under DTC, to be eligible for tax deduction, a policy should give life cover of at least 20 times the annual premium. If this condition is not met, you will not get any tax deduction on the premium and even the income from the policy will be taxable.

Right now income received from insurance policies is free. So make sure if you are looking for tax deduction on insurance plan, you buy a policy which offers a bigger cover. This is possible only if term plan is for duration of 20 to 25 years. Bigger the cover, better for the policyholder.

Another not so good news is that tax deduction limit for life insurance will get reduced from present Rs 1 lakh an year to Rs 50,000 an year. This annual limit of Rs 50,000 will include the amount paid for tuition fees of children as well as medical insurance for self and parents. So an insurance policy with a large premium, around Rs 80,000 to Rs1 lakh will fetch maximum tax deduction of only Rs 50,000.

The DTC will also nudge policyholders to take long-term view on investments. Premature withdrawals from ULIPs will be taxed, so think twice before deciding on an insurance policy. Agents telling you that surrender charges have been waived off and you can withdraw money after five years without paying anything won't hold true anymore.

How DTC 2012 will change the way you save tax

Exemption on long term capital gains continuing is definitely positive news here. Investors can continue with their investments as planned without any need to rejig them due to DTC.

Definite impact on Pension Funds

Under the DTC, most of current tax saving investment will not be eligible for deduction. Instead focus has shifted to long-term options with pension funds leading the way. An annuity is an investment that gives out a regular income to the investor. Pension plans require an investor to put at least 65 per cent of corpus received on maturity in an annuity which then gives her/him monthly pension.

Though more details are awaited, DTC has proposed to make annuity income exempt from taxation, which makes them good tax saving instrument. The New Pension Scheme is low cost pension fund an investor can consider.

How DTC 2012 will change the way you save tax

The repayment of principal of your home loan will not be eligible for tax deduction under the DTC. But there is also a bright spot wherein there is removal of tax on notational rent.

Right now people who own more than one house have to pay tax on notational rental income even if second house is lying vacant. The DTC will remove this anomaly and make investment in second home more tax efficient. Another landlord friendly move is that advanced tax received from a tenant will be taxed in year it relates, not when it was received.

DTC, more importantly has retained tax benefit on the interest paid on home loan. The tax benefits reduce the effective cost of home loan thus making it affordable for borrowers.

How DTC 2012 will change the way you save tax

Most significant point here is that earlier proposal of taxing withdrawals from PPF is junked.

Another significant change that will impact investments in debt funds is the new rule for calculating the indexation of capital gains. Indexation takes into account inflation during the holding period and allows investor to adjust his buying price.

The DTC has changed this and the asset will have to be held for more than one year from the end of financial year in which it was bought to avail indexation benefits. This is a significant change and will impact the way investors in FMPs and debt funds use this benefit.